Effect of board size, board independence, female director, audit committee and leverage on

firm performance: A case of Nepalese commercial banks

Nirvik Shrestha, Prabina Dawadee, Prasidhha Khand and Priya Yadav
Abstract

This study examines the effect of corporate governance on the performance of Nepalese commercial
banks. Return on assets and return on equity are the dependent variables. The independent variables are
board size, leverage, board independence, female director and audit committee. This study is based on
secondary data of 14 commercial banks with 101 observations for the different period. The data are
collected from the Banking and Financial Statistics published by Nepal Rastra Bank and annual reports
of the selected commercial banks. The regression models are estimated to test the significance and impact
of corporate governance on the performance of Nepalese commercial banks.

The study shows that the board size has a negative relationship with return on assets. It indicates that
larger board size leads to decrease in return on assets. However, female director has a positive
relationship with return on assets which indicates that increase in female directors leads to increase in
return on assets. Similarly, audit committee size has positive relationship with return on assets. It
indicates that larger the audit committee size, higher would be return on assets. The result also shows
that leverage has a negative relationship with return on assets which reveals that increase in leverage
ratio leads to decrease in return on assets. The result shows that the board size has a negative
relationship with return on equity. It indicates that larger board size leads to decrease in return on
equity. However, board independence has a positive relationship with return on equity which indicates
that increase in outside directors leads to increase in return on equity. Similarly, audit committee size has
positive relationship with return on equity. It indicates that larger the audit committee size, higher would
be return on equity. The result also shows that leverage has a negative relationship with return on equity
which reveals that increase in leverage ratio leads to decrease in return on equity. The regression results
show that the beta coefficients for leverage, female director and board size are negative with return on
equity. The result also shows that board dependence and audit committee have positive impact on the
return on equity. Likewise, the beta coefficients for audit committee and female director are positive and
significant with return on assets.

Keywords: Return on assets, return on equity, board size, board independence, leverage, female director,
and audit committee.

I. Introduction
Corporate governance is recognized as one of the most important implications to build a
marketplace confidence and to attract positive investors in the organization specifically and the
economy generally. Promoting good corporate governance standards considered to be very
important in attracting investment capital, reducing risk and developing firms’ performance
(Ahmed and Hamdan, 2015). Corporate governance focuses on the structures and processes for
the business direction and management of firms. It involves the relationships among company’s
controlling system, roles of its board directors, shareholders and stakeholders. Williamson (1988)
considered that the corporate governance has relation with transaction cost and, in turn, enhances
firm performance. In addition, weak corporate governance reduces investor confidence and
discourages outside investment. According to Claessens et al. (2002), good governance gives the
firm advantage to get external financing, provide favorable treatment to the shareholders and
reduces cost of capital.
Mehrabani and Dadgar (2013) examined the impact of corporate governance on firm
performance in listed companies on Tehran Stock Exchange (TSE). The study found positive
relationship between corporate governance and firm performance. Similarly, Gupta and Sharma
(2014) examined the impact of corporate governance variables on firm performance in Indian
and South Korean companies. The results illustrated that corporate governance has limited effect
on both the company's share prices as well as on their financial performance. Likewise, Onakoya
et al. (2014) explored the effect of corporate governance characteristics on bank performance in
Nigeria. The study found that both of board size and ownership structure have positive impact on
return on equity. Nevertheless, the study found that corporate governance practices is negatively
associated with companies' assets.
The board of directors acts as an internal governance mechanism through its appointment,
supervision and remuneration of senior managers, as well as its framing of corporate strategy
(Campbell and Vera, 2010). In this era, the presences of women on boards of directors have
increased (Dezsö and Ross, 2012). According to Matter (2010), about 72 percent of directors are
aware that female directors can increase a firm’s performance.
According to Guo and Kumara (2012), size of board of directors is negatively associated with the
value of the firm and positive effect of proportion of outside directors on operating performance
of a firm. Danoshana and Ravivathani (2014) explored the effect of corporate governance on
business performance of 25 listed financial institutions in Sri Lanka for during the period 2008-
2012.The study showed that corporate governance variables have significant effect on business's
performance. Similarly, boards of director’s size and audit committee size have positive effect on
the firm performance. Nevertheless, the study revealed that meeting frequency is negatively
associated with firm performance.
Krafft et al. (2013) investigated the relationship of corporate governance among value and firm's
performance. The analysis concentrates on mergers, investigates the system of how non US
corporations are adopting the US best practice with its propositions. Based on the empirical
analysis of the study, the study found that many that corporations are significantly adopting US
corporations’ best practice associated to corporate governance. Sami et al. (2011) carried out a
study to demonstrate the link between among operating performance and corporate governance
of Chinese listed companies. The findings showed that firm performance is positively associated
with different measures of governance.
According to Fooladi et al. (2014), there is an insignificant relationship of independent directors,
size of the board of directors and ownership structure with the performance of 30 Malaysian
firms. Shafique et al. (2014) attempted to find out the relationship between the board’s gender
diversity and the firm’s performance particularly in the banking sector of Pakistan. The results
showed that number of women on board has a significant impact on firm’s performance.
However, percentage of women on board and presence of female CEO has insignificant impact
on firm’s performance. Emmanuel and Hodo (2012) examined corporate governance impact
on the bank performance by taking the sample of the Nigerian bank. The study found that the
size of the board has positive impact on the return on equity and return on the assets. Fanta et al.
(2013) also examined corporate governance and financial performance of selected commercial
banks in Uganda. The study showed that corporate governance predicts 34.5% of the
variance in the general financial performance of commercial Banks in Uganda.
Feldman and Lankau (2005) mentioned that female directors have leadership traits that increase
their firms’ financial performance. The empirical result showed that the firms with women on
their boards can increase their return on equity (ROE) by 10 percent, operating income by 48
percent and stock growth by 17 percent compared to the industry averages. Likewise, Eagly and
Johannesen-Schmidt (2001) highlighted that the presence of female directors improves five
leadership traits which are people development, expectations and rewards, becoming a role
model, providing inspiration and participative decision making. On the other hand, Darmadi
(2010) and Lam et al. (2013) mentioned female directors will decrease the performance of their
firms.
Female executives are more diligent in their monitoring and demand more audit efforts than male
directors do (Adams and Ferreira, 2009). Female directors’ oversight could also minimize
agency issues (Erhardt, 2003). Women are better able to lower operating costs and improve the
financial performance (Strom et al., 2014). Garcia-Meca et al. (2015) suggested the presence of
women on the boards of banks improves their governance, which causes the bank to be more
profitable. Similarly, Dezsö and Ross (2012) mentioned that female representation in top
management will enrich the information and social diversity of a board, which can bring benefits
to management, enrich the manager’s behaviour and motivate the women in middle
management. Hence, female representation remains an important indicator of the success of
firms. Similarly, Francoeur et al. (2006) found empirical evidence that having a higher
proportion of women does generate positive and significant abnormal returns in the context of
Canadian firm.
Cornett et al. (2008) found a positive relationship between the number of independent directors
and firm performance, and this relationship becomes stronger after adjusting for the impact of
earnings management. Similarly, Vo and Nguyen (2014) found a positive relationship between
the proportion of independent directors and firm performance. Likewise, Agrawal and Knoeber
(1996) investigated 400 large US firms, and found that the firms with a majority-outside board
had reduced performance as compared to those that did not have majority outside boards.
Furthermore, Bhagat and Black (2002) found a significant negative correlation between firm
performance and board independence in the context of 934 large US corporations. Vintila et al.
(2015) examined 51 high-tech US companies over the period 2000-2013. The study found that
the relationship between the proportion of non-executive board members and firm performance
is negative.
In the context of Nepal, Silwal (2016) found a negative relationship between board size and
firms performance. However, Bhandari et al. (2016) found positive impact of board size and firm
size on return on assets and return on equity of the commercial banks. According to Shakya et al.
(2015), there is a negative and significant relationship between board size and return on assets.
Likewise, the board meetings and number of executive committee have positive and significant
relationship with return on assets and Tobins q.

The above discussion reveals that there is no consistency in the findings of various studies
concerning the impact of different corporate governance variables on firm performance.

The main purpose of the study is to analyze the relationship between corporate governance and
firm performance of Nepalese commercial banks. Specifically, it examines the impact of board
independence, board size, female director, audit committee and leverage on firm performance of
Nepalese commercial banks.

The remainder of this study is organized as follows. Section two describes the sample, data and
methodology. Section three presents the empirical results and the final section draws conclusion
and discusses the implications of the study findings.

2. Methodological aspects
The study is based on secondary data which were gathered from 14 Nepalese commercial banks
from 2009/10 to 2016/17, leading to a total of 101 observations. The main sources of data
include Banking and Financial Statistics published by Nepal Rastra Bank and annual reports of
the selected commercial banks. Table 1 shows the number of commercial banks selected for the
study along with the study period and number of observations.
Table 1: Number of commercial banks selected for the study along with study period and
number of observations

S. N. Name of commercial banks Study period Observations

1 Agriculture Development Bank Limited 2009/10-2016/17 8
2 Everest Bank Limited 2009/10-2016/17 8
3 Himalayan Bank Limited 2009/10-2016/17 8
4 Nepal SBI Bank Limited 2009/10-2016/17 8
5 Standard Chartered Bank Nepal Limited 2009/10-2016/17 8
6 Siddhartha Bank Limited 2009/10-2016/17 8
7 Machhapuchchhre Bank Limited 2009/10-2016/17 8
8 NMB Bank Limited 2009/10-2016/17 7
9 Nabil Bank Limited 2009/10-2016/17 8
10 Nepal Bank Limited 2015/16-2016/17 2
11 Rastriya Banijya Bank Limited 2010/11-2016/17 6
12 Nepal Investment Bank Limited 2008/09-2016/17 9
13 Kumari Bank Limited 2009/10-2015/16 7
14 Nepal Bangladesh Bank Limited 2010/11-2016/17 6
Total number of observations 101
Thus, the study is based on the 101 observations.

The model

The models used in this study assume that the firm performance depends upon different
corporate governance variables. The dependent variables are return on assets and return on
equity. The selected independent variables in this study are board independence, board size,
female director, audit committee and leverage. Therefore, the model takes the following forms:
Firm performance = f (board independence, board size, female director, audit committee and
leverage).
More specifically, the given model has been segmented into following models:
ROAit = β0 + β1 ACit + β2 BSit + β3 BIit + β4 FDit + β5 LEVit + εit
ROEit = β0 + β1 ACit + β2 BSit + β3 BIit + β4 FDit + β5 LEVit + εit
Where,
ROA= Return on assets is the ratio of net income to total assets of the firm, in percentage.
ROE= Return on equity is the ratio of net income to total equity of the firm, in percentage.
LEV= Leverage is the ratio of total debt to total assets, in percentage.
BS = Board size represents the total number of directors in the board, in numbers.
BI = Board independence is the number of independent directors on the board, in numbers.
FD= Female director is the number of female director on board, in numbers.
AC = Audit committee is the number of member in an audit committee, in numbers.

The following section describes the independent variables used in this study.
Board size
Guest (2009) examined the impact of board size on firm performance for a large sample of 2746
UK listed firms over 1981–2002. The study found that there is a negative relation between firm
performance and larger boards. Sah and Stiglitz (1991) noticed that bigger groups had a
diversification of opinions effect, which lowered the likelihood of accepting bad projects.
According to that, larger boards could be preferable due to more thought-out decisions.
Nevertheless, the majority of studies on this relationship found evidence that smaller boards
more often result in a good performance (Lipton and Lorsch, 1992 and Yermack, 1996). Based
on it, this study develops the following hypothesis:
H1: There is a negative relationship between board size and bank performance.
Board independence
Board independence refers to the number of independent directors on the board relative to the
total number of directors. The role of independent directors on the board is to effectively monitor
and control firm activities in reducing opportunistic managerial behaviors and expropriation of
firm resources. According to Fuzi et al. (2016), there is a mixed association between proportions
of independent directors and firm performance. Although the companies comprised the highest
number of independent directors, it would not assure to enhance firm performance. Similarly,
Ararat et al. (2010) found that there is a negative relationship between independent directors and
firm’s performance in the context of Turkish firms. Based on it, this study develops the
following hypothesis:
H2: There is a negative relationship between board independence and banks performance..
Leverage
Ilyukhin (2015) examined the relationship between financial leverage and firm performance of
Russian joint-stock companies. The study showed that there is negative impact of financial
leverage on Russian firms’ performance. Similarly, Bui (2017) revealed that there were strong
negative impacts of financial leverage measured by long term debt ratio and total debt ratio on
performances of ROA and ROE in the context of 18 British Gas and Oil companies. According
to Salim and Yadav (2012), there is a negative association between financial leverage and firm
value when testing a data of financial statements of 237 Malaysian companies from 1995 to
2011. Based on it, this study develops the following hypothesis:
H3: There is a negative relationship between leverage and bank performance.

Female director

Erhardt et al. (2003) examined the relationship between the demographic diversity of boards of
directors with the firms’ performance for 127 large US companies. The result showed that board
diversity is positively associated with firm performance. Likewise, Krishnan and Daewoo (2005)
mentioned that the proportion of female directors has positively significant effect on firm
performance. Similarly, Smith et al. (2006) showed that a more gender diverse board may also
improve a firm’s competitive advantage as well as its corporate image and has a positive effect
on customers’ behavior. Based on it, this study develops the following hypothesis:
H4: There is a positive relationship between female director and banks performance.
Audit committee
Porter and Gendall (1993) observed that an audit committee should comprise not less than three
members with the majority of non-executive directors. A large composition of non-executive
directors in an audit committee would optimize the reputation of an audit committee as a good
monitor. According to Akpey and Azembila (2016), the number of independent members of the
audit committee with finance or accounting degrees has negative impact on the firm’s
performance of public traded stocks on the Ghana Stock exchange. Similarly, Aldamen et al.
(2012) revealed that smaller audit committees with more experience and financial expertise are
more likely to be associated with positive firm performance in the market. Based on it, this study
develops the following hypothesis:
H5: There is a negative relationship between audit committee and banks performance.
3. Results and discussion
Descriptive statistics
Table 2 presents the descriptive statistics of the selected dependent and independent variables
during the period 2011/12 to 2016/17.
Table 2: Descriptive statistics for selected Nepalese commercial banks

This table shows the descriptive statistics of dependent and independent variables of commercial
banks for the study period of 2011/12 to 2016/17. The dependent variables are ROA (return on assets
is the ratio of net income to total assets of the firm, in percentage), and ROE (return on equity is the ratio
of net income to total equity of the firm, in percentage). The independent variables are LEV (leverage is
the ratio of total debt to total assets, in percentage), BS (board size represents the total number of
directors in the board, in numbers), BI (board independence is the number of independent directors on
the board, in numbers), FD (female director is the number of female director on board, in numbers) and
AC (audit committee is the number of member in an audit committee, in numbers).

Variables Minimum Maximum Mean S.D.

BS 4 11 7.61 1.37
BI 0 1 0.99 0.1
 FD 0 2 0.46 0.62
AC 1 6 3.35 0.899
ROA -1 8 1.86 1.12
ROE -52.32 102.11 20.42 16.74
LEV 78 113 90.99 4.9

The table shows that the return on assets ranges from a minimum of -1 percent to a maximum of
8 percent, leading to an average of 1.86 percent. Similarly, audit committee size ranges from a
minimum of 1 member to a maximum of 6 members, leading to an average of 3 members.
Similarly, board size ranges from minimum of 4 members to the maximum of 11 members,
leading to an average of 7 members.

Correlation analysis
Having indicated the descriptive statistics, Pearson’s correlation coefficients are computed. The
Pearson’s correlation coefficients for the selected Nepalese commercial banks have been
computed and the results are presented in Table 3.
Table 3: Pearson’s correlation coefficients matrix for selected Nepalese commercial banks
This table shows the bivariate Pearson’s correlation coefficients between dependent and independent
variables of commercial banks for the study period of 2011/12 to 2016/17. The dependent variables are
ROA (return on assets is the ratio of net income to total assets of the firm, in percentage), and ROE
(return on equity is the ratio of net income to total equity of the firm, in percentage). The independent
variables are LEV (leverage is the ratio of total debt to total assets, in percentage), BS (board size
represents the total number of directors in the board, in numbers), BI (board independence is the number
of independent directors on the board, in numbers), FD (female director is the number of female director
on board, in numbers) and AC (audit committee is the number of member in an audit committee, in
numbers).

Variables BS BI FD AC LEV ROA ROE

BS 1
BI 0.045 1
FD 0.148 0.073 1
AC -0.109 -0.073 0.268** 1
LEV -0.144 0.020 -0.394** -0.203* 1
ROA -0.177 -0.102 0.248* 0.276** -0.327** 1
ROE -0.172 0.122 -0.157 0.130 -0.037 0.352** 1
Note: The asterisk signs (**) and (*) indicate that the results are significant at 1percent and 5 percent levels
respectively.

The result reveals that the board size has a negative relationship with return on assets. It indicates
that larger board size leads to decrease in return on assets. However, female director has a
positive relationship with return on assets which indicates that increase in female directors leads
to increase in return on assets. Similarly, audit committee size has positive relationship with
return on assets. It indicates that larger the audit committee size, higher would be return on
assets. The result also shows that leverage has a negative relationship with return on assets which
reveals that increase in leverage ratio leads to decrease in return on assets.

The result shows that the board size has a negative relationship with return on equity. It indicates
that larger board size leads to decrease in return on equity. However, board independence has a
positive relationship with return on equity which indicates that increase in outside directors leads
to increase in return on equity. Similarly, audit committee size has positive relationship with
return on equity. It indicates that larger the audit committee size, higher would be return on
equity. The result also shows that leverage has a negative relationship with return on equity
which reveals that increase in leverage ratio leads to decrease in return on equity.

Regression analysis
Having indicated the Pearson’s correlation coefficients, the regression analysis has been
computed and results are presented in the Table 4. More specifically, it shows the regression
results of impact of board size, leverage, female director, audit committee, independence director
on return on equity of Nepalese commercial banks.
Table 4: Estimated regression of board size, leverage, female director, audit committee,
independence director on return on equity
The results are based on panel data of 14 commercial banks with 101 observations for the period of
2011/12 to 2016 /17 by using linear regression model. The model is ROE =. β0 + β1 LEVit + β2 BSit + β3
BIit + β4 FDit + β5 ACit + εit where, the dependent variable is ROE (return on equity is the ratio of net
income to total equity of the firm, in percentage). The independent variables are LEV (leverage is the
ratio of total debt to total assets, in percentage), BS (board size represents the total number of directors
in the board, in numbers), BI (board independence is the number of independent directors on the board,
in numbers), FD (female director is the number of female director on board, in numbers) and AC (audit
committee is the number of member in an audit committee, in numbers).
Regression coefficients of Adj. R-
Models Intercept SEE F-value
BS BI FD AC LEV bar2
36.166 -2.073
1
(3.884)** (1.722) 0.019 16.588 2.966
0.272 20.313
2
(0.016) (3.209)** 0.185 16.718 11.463
22.312 -4.234
3
(10.882)** (2.592) ** 0.115 16.626 9.533
12.236 2.435
4
(1.903) (1.312) 0.007 16.12 1.721
32.155 -0.129
5
(1.028) (0.377) 0.009 16.822 0.142
15.272 -2.143 21.641
6
(0.824) (1.785) (2.301)* 0.026 16.530 4.340
7 14.746 25.541 -5.980 3.755
(0.820) (2.546)** (2.196)* (1.985)* 0.051 16.314 7.807
42.853 -6.533 3.280 -0.335
8
(1.218) (2.232)* (1.717) (0.912) 0.036 16.414 6.256
6.150 22.049 2.566 -0.043
9
(0.163) (1.309) (1.348) (0.122) 0.004 16.714 4.148
19.252 2.071 23.138 2.117 -0.144
10
(0.479) (1.687) (1.386) (1.112) (0.411) 0.023 16.554 4.589
Notes:
i. Figures in parentheses are t- values.
ii. The asterisk signs (**) and (*) indicate that the results are significant at 1 percent and 5 percent level respectively.
iii Dependent variable is return on equity.

Table 4 shows that the beta coefficients for board size are negative with return on equity. It
means that board size has negative impact on return on equity. This finding is consistent with the
findings of Guest (2009). However, the beta coefficients for board independence are positive
with return on equity. It indicates that board independence has positive impact on return on
equity. This finding is similar to the findings of Ararat et al. (2010). The result also shows that
the beta coefficients for audit committee size are positive with return on equity. It indicates that
audit committee size has positive impact on return on equity. This finding contradicts with the
findings of Aldamen et al. (2012).
The estimated regression results of board size, leverage, female director, audit committee,
independence director on return on assets of selected Nepalese commercial banks are presented
in Table 5.
Table 5: Estimated regression of board size, leverage, female director, audit committee and
independence director on return on assets
The results are based on panel data of 14 commercial banks with 101 observations for the period of
2011/12 to 2016 /17 by using linear regression model. The model is ROA =.β0 + β1 LEVit + β2 BSit + β3
BIit + β4 FDit + β5 ACit + εit where, the dependent variable is ROA (return on assets is the ratio of net
income to total assets of the firm, in percentage). The independent variables are LEV (leverage is the
ratio of total debt to total assets, in percentage), BS (board size represents the total number of directors
in the board, in numbers), BI (board independence is the number of independent directors on the board,
in numbers), FD (female director is the number of female director on board, in numbers) and AC (audit
committee is the number of member in an audit committee, in numbers).
Regression coefficients of Adj. R-
Models Intercept SEE F-value
BS BI FD AC LEV bar2
2.942 -0.142
1
(5.194)** (1.942)* 0.097 1.009 4.771
2.790 -0.940
2
(2.725)** (0.913) 0.002 1.023 0.834
1.689 0.304
3
(13.684)** (2.332)* 0.143 1.003 5.439
0.828 0.308
4
(2.173)* (2.800)** 0.164 0.989 7.842
7.552 -0.363
5
(4.140)** (3.125)** 0.181 0.980 9.766
3.766 -0.139 -0.853
6
(3.322)** (1.899).* (0.839) 0.024 1.010 8.232
3.964 -0.168 -1.038 0.441
7
(3.611)** (2.347)* (1.053) (2.780)** 0.087 0.977 14.166
1.802 -0.910 0.289 0.247
8
(1.665) (0.915) (1.764) (2.171)* 0.080 0.981 13.882
5.297 0.140 0.230 -0.047
9
(2.572)** (0.817) (2.059)* (2.184)* 0.115 0.962 15.337
8.520 -0.156 -0.644 0.209 -0.061
10
(3.718)** (2.236)* (0.676) (1.931) (3.046)** 0.149 0.943 15.385
Notes:
i. Figures in parentheses are t- values.
 ii. The asterisk signs (**) and (*) indicate that the results are significant at 1 percent and 5 percent level
respectively.
iii. Dependent variable is return on assets.

Table 5 shows the beta coefficients for board independence are negative with return on assets. It
indicates that board independence has negative impact on return on assets. This finding is similar
to the findings of Ararat et al. (2010). Similarly, the result shows that the beta coefficients for
board size are negative with return on assets. It means that board size has negative impact on
return on assets. This finding is consistent with the findings of Sah and Stiglitz (1991). However,
the result also shows that the beta coefficients for audit committee size are positive with return
on assets. It indicates that audit committee size has positive impact on return on assets. This
finding contradicts with the findings of Akpey and Azembila (2016).

4. Summary and conclusion

Corporate governance is viewed as an indispensable element of market discipline. This is
fuelling demands for strong corporate governance mechanisms by investors and other financial
market participants. The issue seems to revolve around putting the right rules, regulations and
incentives in place to ensure transparency and accountability in the management of the affairs of
corporate entities.
This study attempts to examine the impact of corporate governance on the financial performance
of Nepalese commercial banks. The study is based on secondary data of 14 commercial banks
with 101 observations during the period 2008/09-2016/17.

The study shows that female director and audit committee have positive and significant impact
on return on assets. However, the result shows that board size and number of independent
directors have negative impact on return on assets. Similarly, the result also shows that board
independence and audit committee have positive and significant impact on return on equity. The
study concludes that corporate governance has significant impact on the performance of
Nepalese commercial banks. The study also concludes that leverage followed by audit committee
and female directors is the most influencing factor that explains the performance of Nepalese
commercial banks.
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